ESCA 

EMPLOYEE-OWNED S CORPORATIONS OF AMERICA

 

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Prepared Statement of Linda E. Carlisle 

General Counsel 

Employee-owned S Corporations of America (“ESCA”) 

Before the Department of Labor 

Public Hearing on 

“Definition of Fiduciary – Investment Advice” 

March 2, 2011 

Good morning. My name is Linda E. Carlisle. I am a partner at White & Case LLP and I 

have served as general counsel to the Employee-Owned S Corporations of America (“ESCA”) 

since its creation. ESCA is the national voice for S corporations owned by employee stock 

ownership plans (“ESOPs”). ESCA’s members include privately-held ESOP-owned S 

corporations and many professional advisory firms that serve the ESOP community. 

ESCA, its member companies, and their tens of thousands of employee owners appreciate 

the opportunity to address the Department of Labor’s (“DOL’s”) proposed amendments to 

regulation 29 C.F.R. § 2510.3-21 (the “Proposed Regulation”) that would expand the types of 

advice and recommendations that constitute rendering “investment advice” for purposes of the 

definition of a “fiduciary” under section 3(21)(A)(ii) of the Employee Retirement Income 

Security Act (“ERISA”). In particular, the Proposed Regulation would make the provision of an 

appraisal or fairness opinion to an ESOP concerning the value of securities or other property 

“investment advice” with the result that the duties and liabilities of an ERISA fiduciary would be 

imposed on any person providing such an appraisal or fairness opinion. 

ESOPs are required under section 4975(e)(7) of the Internal Revenue Code to be 

designed to invest primarily in employer securities. Section 401(a)(28)(C) of the Internal 
Revenue Code requires an ESOP to obtain valuations of employer securities by an independent 

appraiser at least annually. In addition, section 4975(d)(13) of the Internal Revenue Code and 

section 408(e) of ERISA provide that an ESOP may not purchase employer securities for more 

than “adequate consideration” (i.e., the fair market value of the employer securities as 

determined in good faith by the ESOP trustee or the named ERISA fiduciary). Since S 

corporation stock is not publicly traded, the ESOP trustee (or the named ERISA fiduciary with 

respect to the ESOP) cannot rely on market prices or quotations to determine the fair market 

value of employer securities. Accordingly, such ESOP trustee or ERISA fiduciary generally 

engages an expert appraiser to give advice regarding the fair market value of the employer 

securities. ESCA members therefore have a keen interest in the effects that the Proposed 

Regulation would have on the advisors who provide appraisal services to S corporation ESOPs 

and the ability of the S corporation ESOPs to obtain expert assistance and advice in performing 

required valuations of employer securities. 

Background. 

Section 3(21)(A)(ii) of ERISA defines a “fiduciary” with respect to an employee benefit 

plan to include any person that renders “investment advice” for a fee or other compensation with 

respect to any moneys or other property of such plan or has any authority or responsibility to do 

so. Regulations issued by the DOL in 1975 (the “Regulation”) further defined the circumstances 

under which a person is considered to render investment advice to an employee benefit plan 

within the meaning of section 3(21)(A)(ii) of ERISA. Under the Regulation, a person that does 

not have discretionary authority or control with respect to the purchase or sale of securities or 

other property for the plan is considered to render investment advice only if five conditions are 

met: 

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1. Such person renders advice as to the value of securities or other property, or 

makes recommendations as to the advisability of investing in, purchasing or 

selling securities or other property; 

2. Such advice is rendered on a regular basis; 

3. Such advice is rendered pursuant to a mutual agreement, arrangement, or 

understanding, with the plan or a plan fiduciary; 

4. Such mutual agreement, arrangement or understanding is that the advice will 

serve as a primary basis for investment decisions with respect to plan assets; and 

5. Such mutual agreement, arrangement, or understanding is that the advice will be 

individualized based on the particular needs of the plan. 

Shortly after the promulgation of the Regulation, the DOL in 1976 issued Advisory 

Opinion 76-65A, which concluded that a valuation of closely-held employer securities to be 

purchased by an ESOP that did not involve an opinion as the relative merits of purchasing the 

securities, but that would be relied upon in purchasing such securities, would not constitute 

investment advice under the Regulation. Thus, in Advisory Opinion 76-65A, the DOL 

specifically considered whether a person who provides an ESOP with a valuation opinion with 

respect to closely-held employer securities would be considered to be rendering investment 

advice and concluded that rendering such an opinion, by itself, would not constitute rendering 

investment advice for purposes of section 3(21)(A)(ii) of ERISA. ERISA fiduciary status, 

therefore, is not imposed on persons by reason of their providing valuation opinions to an ESOP 

for purposes of the required annual valuation of employer securities held by the ESOP or for 

purposes of a purchase of employer securities by the ESOP under the current DOL interpretation 

of ERISA. 

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DOL’s Stated Reasons for Changes Affecting ESOP Appraisals. 

The preamble to the Proposed Regulation notes that a common ERISA violation found in 

the DOL’s ESOP enforcement initiatives is the incorrect valuation of employer securities and 

that these cases include instances in which plan fiduciaries have reasonably relied on faulty 

valuations prepared by professional appraisers. The preamble states that the DOL believes that 

broadening the definition of investment advice to include appraisals and fairness opinions 

provided in connection with a plan’s purchase of securities or other property may directly or 

indirectly address these enforcement issues and align the duties of the persons providing such 

appraisals or opinions with those of the plan fiduciaries that rely upon such appraisals or 

opinions. 

Proposed Changes Affecting ESOP Appraisals. 

The Proposed Regulation would expand the types of advice and recommendations that 

result in fiduciary status under section 3(21)(A)(ii) of ERISA to include the provision of an 

appraisal or fairness opinion concerning the value of securities or other property under an 

agreement, understanding or arrangement that such appraisal or opinion may be considered in 

connection with making investment decisions. This change would supersede DOL Advisory 

Opinion 76-65A. Thus, ERISA fiduciary status would be imposed on all persons who provide an 

ESOP with the required annual appraisal of employer securities held by the ESOP or an appraisal 

of employer securities to be purchased by the ESOP. 

ESCA’s Concerns Regarding the Proposed Regulation. 

The Proposed Regulation would expose ESOP appraisers to a major expansion of legal 

liability and increased costs of insurance. ESCA understands that for many of the top-tier 

appraisal firms, ESOP appraisals are not a major component of the firm’s business. ESCA is 

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concerned that such established and well-respected appraisal firms will choose to discontinue 

their ESOP appraisal business rather than face the additional legal exposure and insurance costs 

that would result from the Proposed Regulation. Removing the most experienced and competent 

ESOP appraisers from the ESOP appraisal marketplace will force many ESOPs to use smaller 

and less-experienced appraisers, who may not be able to provide superior service and necessary 

ESOP expertise to ESOPs. 

In addition, the increased insurance costs that ESOP appraisers will incur will inevitably 

be passed on to the ESOPs. ESCA is concerned that such increased costs imposed on the ESOPowned S corporation structure will diminish the retirement savings of the S corporation ESOP 

participants and may discourage the formation of new S corporation ESOPs. 

Thus, ESCA is concerned that expanding the definition of “investment advice” to include 

the valuation of closely-held employer securities that an ESOP is required to obtain at least 

annually or when purchasing employer securities will not improve the quality of the appraisals or 

valuation advice obtained by ESOPs from their current advisors, but will have the perverse effect 

of reducing the number of competent appraisers available to make such valuations and would 

significantly increase the ESOP’s cost of obtaining this necessary service. 

Alternatives. 

Comments with respect to the Proposed Regulation have suggested alternative 

approaches to the problem of incorrect valuations of employer securities held by an ESOP. 

ESCA has not endorsed any specific alternative approaches, but urges the DOL to consider 

alternative means of ensuring correct valuations of employer securities. 

Among the alternative approaches suggested in other comments to the Proposed 

Regulation is that the DOL issue regulations that provide more specific guidance to ESOP 

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fiduciaries regarding their duties to correctly value employer securities. The DOL issued 

proposed regulations in 1988 that set forth guidance regarding how ESOP fiduciaries should 

determine the fair market value of closely-held employer securities to ensure that such valuations 

are good faith determinations of fair market value. The DOL, however, has never finalized those 

proposed regulations. Guidance issued by the DOL in final regulations need not be limited to the 

guidance in the 1988 DOL proposed regulations and could provide specific guidance regarding 

the necessary expertise, training, or experience of persons providing valuations opinions to an 

ESOP. 

Conclusion. 

It has been 35 years since the DOL first issued the regulations that govern the types of 

investment advice relationships that give rise to fiduciary duties on the part of an investment 

advisor. Given the potential problems raised by the Proposed Regulation, ESCA respectfully 

requests that the DOL not adopt the Proposed Regulation until it has thoroughly considered other 

ways to ensure that ESOP-owned S corporations receive reliable appraisals.